IPO

An insider’s view of Chinese M&A — Intralinks Deal Flow Predictor

Leave a Comment / December 8, 2015

intra

Intralinks Dealflow Predictor

 

Intralinks: The meltdown of China’s equity markets that began in the summer, despite measures by officials in Beijing aimed at calming investors’ nerves, has left many global investors jittery. Is this just a correction of an overheated market or the start of something more serious, and how would you describe the mood in China at the moment?

 

Peter Fuhrman: Never once have I heard of a stock market correction that was greeted with glee by the mass of investors, brokers, regulators or government officials. So too most recently in China. The dive in Chinese domestic share prices, while both overdue and in line with the sour fundamentals of most domestically quoted companies, has caused much unhappiness at home and anxiety abroad. The dour outlook persists, as more evidence surfaces that China’s real economy is indeed in some trouble. I first came to China 34 years ago, and have lived full-time here for the last six years. This is unquestionably the worst economic and financial environment I’ve encountered in China. Unlike in 2008, the Chinese government can’t and won’t light a fiscal bonfire to keep the economy percolating. The enormous state-owned sector is overall on life support, barely eking out enough cash flow to pay interest on its massive debts. Salvation this time around, if it’s to be found, will come from the country’s effervescent private sector. It’s already the source of most job creation and non-pump-primed growth in China. The energy, resourcefulness, pluck and risk-tolerance of China’s entrepreneurs knows no equal anywhere in the world. The private sector has been fully legal in China for less than two decades. It is only beginning to work its economic magic.

 

Intralinks: Much has been made of slowing economic growth in China. What are you seeing on the ground and how reliable do you view the Chinese official growth statistics?

 

Peter Fuhrman: If there’s a less productive pastime than quibbling with China’s official statistics, I don’t know of it. Look, it’s beyond peradventure, beyond guesstimation that China’s economic transformation is without parallel in human history. The transformation of this country over the 34 years since I first set foot here as a graduate student is so rapid, so total, so overwhelmingly positive that it defies numerical capture. That said, we’re at a unique juncture in China. There are more signs of economic worry down at the grassroots consumer level than I can recall ever seeing. China is in an unfamiliar state where nothing whatsoever is booming. Real estate prices? Flat or dropping. Manufacturing? Skidding. Exports? Crawling along. Stock market prices? Hammered down and staying down. The Renminbi? No longer a one-way bet.

 

Intralinks: What impact do you see a slowing Chinese economy having on other economies in the APAC region and elsewhere?

 

Peter Fuhrman: Of course there will be an impact, both regionally and globally. There’s only one certain cure for any country feeling ill effects from slowing exports to China: allow the Chinese to travel visa-free to your country. The one trade flow that is now robust and without doubt will become even more so is the Chinese flocking abroad to travel and spend. Only partly in jest do I suggest that the U.S. trade deficit with China, now running at a record high of about $1.5 billion a day, could be eliminated simply by letting the Chinese travel to the U.S. with the same ease as Taiwanese and Hong Kong residents. Manhattan store shelves would be swept clean.

 

Intralinks: With prolonged record low interest rates and low inflation in most of the advanced economies, many multinational companies have looked to China as a source of growth, including through M&A. Which sectors in China have tended to attract the majority of foreign interest? Do you see that continuing or will the focus and opportunities shift elsewhere? Is China a friendly environment for inbound M&A?

 

Peter Fuhrman: The challenges, risks and headaches remain, of course, but M&A fruit has never been riper in China. This is especially so for U.S. and European companies looking to seize a larger slice of China’s domestic consumer market. The M&A strategy that does work in China is to acquire a thriving Chinese private sector business with revenues in China of at least $25m a year, with its own-brand products, distribution, and a degree of market acceptance. The goal for a foreign acquirer is to use M&A to build out most efficiently a sales, brand and product strategy that is optimized for China, in both today’s market conditions, as well as those likely to pertain in the medium- to long-term.

The botched deals tend to get all the headlines, but almost surreptitiously, some larger Fortune 500 companies have made some stellar acquisitions in China. Among them are Nestle, General Mills, ITW, FedEx and Valspar. They bought solid, successful, entrepreneur-founded and run companies. Those acquired companies are now larger, often by orders of magnitude. The acquirer has also dramatically expanded sales of its own global products in China by utilizing the localized distribution channels it acquired. In Nestle’s case, China is now its second-largest market in revenue-terms after the U.S. Four years ago, it ranked number seven.

Chinese government policy towards M&A is broadly positive to neutral. More consequential but perhaps less well-understood are the negative IPO environment for domestic private sector companies, as well as the enormous overhang of un-exited PE invested deals in China. These have transferred pricing leverage from sellers to buyers in China. Increasingly, the most sought-after exit route for domestic Chinese entrepreneurs is through a trade sale to a large global corporation.

 

Intralinks: After years of being seen mainly as “an interested party”, rather than an actual dealmaker, Chinese players are increasingly frequently the successful bidder in international M&A transactions. What has changed in their approach to dealmaking to ensure such success?

 

Peter Fuhrman: Yes, Chinese buyers are increasingly more willing and able to close international M&A deals. But, the commonly-heard refrain that Chinese buyers will devour everything laid in front of them stands miles apart from reality. It seems like every asset for sale in every locale is seeking a Chinese buyer. The limiting factor isn’t money. Chinese acquirers’ cost of capital is lower than anywhere else, often fractionally above zero. The issue instead is too few Chinese companies have the managerial depth and experience to close global M&A deals. There are some world-class exceptions and world-class Chinese buyers. In the last year, for example, a Chinese PE fund called Hua Capital has led two milestone transactions, the proposed acquisition for a total consideration north of $2.5bn, of two U.S.-quoted semiconductor companies, Omnivision and ISSI. Hua Capital has powerful backers in China’s government, as well as outstanding senior executives. These guys are the real deal.

 

Intralinks: When it comes to doing deals, what are the differences between private/public companies and SOEs?

 

Peter Fuhrman: With rare exceptions, the SOE sector is now paralyzed. No M&A deals can be closed. Every week brings new reports of the arrest of senior SOE management for corruption. In some cases, the charges relate directly to M&A malfeasance, bribes, kickbacks and the like. SOE M&A teams will still go on international tire-kicking junkets, but getting any kind of transaction approved by the higher tiers within the SOE itself and by the government control apparatus is all but impossible for now. That leaves China’s private sector companies, especially quoted ones, as the most likely club of buyers. We work with the chairmen of quite a few of these private companies. The appetite is there, the dexterity often less so.

 

Intralinks: China has long been a fertile dealmaking environment for PE funds – both home-grown and international. In what ways does the Chinese PE model differ from what we see in other markets?

 

Peter Fuhrman: Perhaps too fertile. For all the thousands of deals done, Chinese PE’s great Achilles heel is an anemic rate of return to their limited partner investors, especially when measured by actual cash distributions. Over the last three, five, seven years, Chinese PE as a whole has underperformed U.S. PE by a gaping margin. It’s a fundamental truth too often overlooked. High GDP growth rates do not correlate, and never have, with high investment returns, especially from alternative investment classes like PE. If there is one striking disparity between PE as practiced in China as compared to the U.S. and Europe, it’s the fact that that Chinese general partners, whether they’re from the world’s largest global PE firms or pan-Asian or China-focused funds, too often think and act more like asset managers than investors. The 2 takes precedence over the 20.

Intralinks: What opportunities and challenges are private equity investors facing?

 

Peter Fuhrman: The levels of PE and venture capital (VC) investing activity in China have dropped sharply. What money is being invested is mainly chasing after a bunch of loss-making online shopping and mobile services apps. The hope here is one will emerge as China’s next Alibaba or Tencent, the two giants astride China’s private sector. PE investment in China’s “real economy,” that is manufacturing businesses that create most of the jobs and wealth in China, has all but dried up. Though out of favor, this is where the best deals are likely to be found now. Contrarianism is an investing worldview not often encountered at China-focused PE and VC firms.

 

Intralinks: As in many other markets, PE investors are having to deal with a backlog of portfolio companies ready to be exited. Do you feel that PE’s focus on minority investments in China could prove a challenge when it comes to exiting those investments? What do you see as the primary exit route?

 

Peter Fuhrman: Exits remain both few in number and overwhelmingly concentrated on a single pathway, that of IPO. M&A exits, the main source of profit for U.S. and European PE firms, remain exceedingly rare in China. In part, it’s because PE firms usually hold a minority stake in their Chinese investments. In part, though, the desire for an IPO exit is baked into the PE investment process in China. Price/Earnings (P/E) multiple arbitrage, trying to capture alpha through the observed delta in valuation multiples between private and public markets, remains a much-beloved tactic.

 

Intralinks: Finally, what is your overall outlook on China and advice for foreign companies and investors seeking opportunities to engage in M&A or invest there?

 

Peter Fuhrman: Yes, China’s economy is slowing. But the salient discussion point within boardrooms should be that even at 5% growth, China’s economy this year is getting richer faster in dollar terms than it did in 2007 when GDP growth was 14%. That’s because the economy is now so much larger. This added increment of wealth and purchasing power in China in 2015 is larger than the entire economies of Taiwan, Malaysia, Thailand, and Hong Kong. Much of the annual gain in China, likely to remain impressively large for many long years to come, filters down into increased middle class spending power. This is why China must matter to global businesses with a product or service to sell. M&A in China has a cadence and quirks all its own. But, the business case can often be compelling. The terrain can be mastered.

 

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“A lot hasn’t gone to plan”: SuperReturn Interview

Leave a Comment / December 14, 2015

Superretrun

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Does [China’s] shift from a manufacturing-driven economy to a service-driven one make macroeconomic shocks like those seen this summer inevitable?

Peter Fuhrman: China has enjoyed something of a worldwide monopoly on hair-raising economic news of late: a stock market collapse followed by a klutzy bail-out, then a devaluation followed by a catastrophic explosion and finally near-hourly reports of sinking economic indicators. As someone who first set foot in China 34 years ago, my view is we’re in an unprecedented time of economic and financial uncertainty . Consumers and corporates are noticeably wobbling. For a Chinese government long used to ordering “Jump!” and the economy shouting back “How high?” this is not the China they thought they were commanding.  Everyone is looking for a bannister to grab.

And yet, China still has some powerful fundamentals working in its favour. Urbanization is a big one. It alone should add at least 3-4% to annual GDP a year for many years to come. The shift towards services and domestic growth as opposed to exports are two others. For now, these forces are strong enough to keep China propelling forward even as it tows heavy anchors like an ageing population, and a cohort of monopolistic state-owned enterprises (SOEs) that suck up too much of China’s capital and often achieve appalling results with it.

Look, the Chinese stock market had no business in the first place almost tripling from June last year to June of this. The correction was long, long overdue. It’s often overlooked that China’s domestic stock market has a pronounced negative selection bias. Heavily represented among the 3,000 listed companies are quite a number of China’s very worst companies, with the balance made up of lethargic, low-growth, often loss-making SOEs. The good companies, like Tencent or Baidu, predominantly expatriate themselves when it comes time to IPO. To my way of thinking, China’s domestic market still seems overpriced. The dead cats are, for now, still bouncing.

 

Given this overall picture, do you expect to see greater or fewer opportunities [in China] for alternative investments and why? 

Peter Fuhrman: The environment in China has been challenging, to say the least, for alternative investment firms not just in the last year, but for the better part of the last decade. A lot hasn’t gone to plan. China’s growth and opportunities proved alluring to both GPs and LPs. And yet too often, almost systematically, the big money has slipped between their fingers. Partly it’s because of too much competition, and with it ballooning valuations, from over 500 newly-launched domestic Chinese PE and VC firms. The fault also sits with home-grown mistakes, with errors by private equity firms in investment approach. This includes an excessive reliance on a single source of deal exit, the IPO, all but unheard-of in other major alternative investment environments.

Overall PE returns have been lacklustre in China, especially distributions, before the economy began to slip off the rails. In the current environment, challenges multiply. A certain rare set of investing skills should prove well-adapted: firms that can do control deals, including industry consolidating roll-ups. In other words, a whole different set of prey than China PE investors have up to now mainly stalked. These are not pre-IPO deals, not ones predicated on valuation arbitrage or the predilections of Chinese young online shoppers. There’s money to be made in China’s own Rust Belt, backing solid well-managed manufacturers, a la Berkshire Hathaway. There’s too much fragmentation across the industrial board. China will remain the manufacturing locus for the world, as well as for its own gigantic domestic market.

Another anomaly that needs correcting: Global alternative investing has been overwhelmingly skewed in China towards equity not debt. The ratio could be as high as 99:1. This imbalance looks even more freakish when you consider real lending rates to credit-worthy corporates in China are probably the highest anywhere in the advanced world, even a lot higher than in less developed places like India and Indonesia. Regulation is one reason why global capital hasn’t poured in in search of these fat yields. Another is the fact PE firms on the ground in China have few if any team members with the requisite background and experience to source, qualify, diligence and execute China securitized debt deals. There’s a bit of action in the China NPL and distress world. But, straight up direct collateralized lending to China’s AA-and-up corporates and municipalities remains an opportunity global capital has yet to seize. Meanwhile, China’s shadow banking sector has exploded in size, with over $2.5 trillion in credit outstanding, almost all of which is current. There’s big money being made in China’s securitized high-yield debt, just not by dollar investors.

 

What’s the overall story of alternative investors engaging with central planning? How would you characterise the regulatory environment?

Peter Fuhrman: China has had a state regulatory and administrative apparatus since Europeans were running around in pelts and throwing spears at one another. So, yes, there is a large regulatory system in China overseen by a powerful government that is very deeply involved in economic and financial planning and rule-making. One must tread carefully here. Rules are numerous, occasionally contradictory, oft-time opaque and liable to sudden change.

Less observed, however, and less harrowing for foreign investors is the core fact that the planning and regulatory system in China has a strong inbuilt bias towards the goal of lifting GDP growth and employment. Other governments talk this talk. But it’s actually China that walks the walk. The days of anything-goes, rip-roaring, pollute-as-you-go development are about done with. But, still the compass needle remains fixed in the direction of encouraging strong rates of growth.

The Chinese government has also gotten more and more comfortable with the fact that most of the growth is now coming from the highly-competitive, generally lightly-regulated private sector. Along with a fair degree of deregulation lately in industries like banking and transport, China also often pursues a policy of benign neglect, of letting entrepreneurs duke it out, and only imposing rules-of-the-game where it looks like a lot of innocents’ money may be lost or conned. To be sure, foreign investors in most cases cannot and should not operate in these more free-form areas of China’s economy. They often seem to be the first as well as the fattest targets when the clamps come down. Just ask some larger Western pharmaceutical companies about this.

 

In the long view, how long can the parallel USD-RMB system run? Do you expect to see the experiments in Shanghai’s Pilot Free Trade Zone (FTZ) replicated and extended? 

Peter Fuhrman: Unravelling China’s rigged exchange rate system will not happen quickly. Every baby step — and the steps are coming more fast of late — is one in the direction of a more open capital account, of greater liberalization. But, big change will all unfold with a kind of stately sluggishness in my view. Not because policy-makers are particularly wed to the notion of an unconvertible currency. There’s the deadweight problem of nearly $4 trillion in foreign exchange reserves. What’s the market equilibrium rate of the Dollar-Renminbi? Ask someone facing competition from a Chinese exporter and they’re likely to say three-to-one, or an almost 100% appreciation. Ask 1.4 billion Chinese consumers and they will, with eminent good reason, say it should be more like 12-to-one. Prices of just about everything sold to consumers in China is higher, often markedly higher, than in the US where I’m from. This runs from fruit, to supermarket staples, to housing, brand-name clothing up to ladder to cars and the fuel that powers them.

I think the irrational exuberance about Shanghai’s FTZ has slammed into the wall of actual central government policy of late.  It will not, cannot, act like a free market pathogen.

 

Reform of China’s state-owned enterprises has been piecemeal, and private equity has had patchy success with SOEs. Do you expect this to change, and why?

Peter Fuhrman: For those keeping score, reform of SOEs has yet to really put any points on the board. The SOE economy-within-an-economy remains substantially the same today as it was three years ago. Senior managers continue to be appointed not by competence, vision and experience, but by rotation. The major shareholder of all these SOEs, both at centrally-administered level as for well as those at provincial and local level, act like indifferent absentee proprietors, demanding little by way of dividends and showing scant concern as margins and return-on-investment droop year-by-year at the companies they own.

There are good deals to be done for PE firms in the SOE patch. The dirty little secret is that the government uses a net asset value system for state-owned assets that is often out-of-kilter with market valuations. Choose right and there’s scope to make money from this. But, if you’re a junior partner behind a state owner who cares more about jobs-for-the-boys than maximizing (or even earning) profits then no asset however cheaply bought will ever really be in the money.

 

TPP has been described as ‘a club with China left out’. If it comes to pass, how do you expect China to respond?

Peter Fuhrman: China has responded. Along with its rather clumsy-sounding “One Belt, One Road” initiative it also has its Asia Infrastructure Investment Bank. The logic isn’t alien to me. When American Jews were barred from joining WASP country clubs, they tried to build better clubs of their own. When Chase Manhattan, JP Morgan and America’s largest commercial banks wouldn’t hire Jews, they went instead into investment banking, where there was more money to be made anyway.

But, China may not so easily and successfully shrug off their exclusion from TPP. It increases their aggrieved sense of being ganged-up upon. The US understands this and now frets more about China’s military power. The partners China are turning to instead – especially the countries transected by the “One Belt, One Road” – look more like a cast of economic misfits, not dynamic free traders like the TPP nations and China itself. I don’t think anyone in Beijing seriously believes that increased trading with the Central Asian -stans is a credible substitute. Even so, China will not soon be invited to join the TPP. China has hardly acted like a cozy neighbour of late to the countries with the markets and with the money. Being feared may have its strategic dividends. But the neighbourhood bully rarely if ever gets invited to the block party.

 

Peter Fuhrman will be speaking at SuperReturn Asia 2015, 21-24 September 2015, JW Marriott, Hong Kong.

 

http://www.superreturnasia.com/blog/super-return-private-equity-conference/post/id/7653_A-lot-hasnt-gone-to-plan-Peter-Fuhrman-China-First-Capital-on-alternative-investments-in-the-PRC?xtssot=0

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China 2015 — China’s Shifting Landscape — China First Capital new research report published

Leave a Comment / July 20, 2015

China First Capital research report

 

Slowing growth and a gyrating stock market are the two most obvious sources of turbulence in China at the midway point of 2015. Less noticed, perhaps, but certainly no less important for China’s long-term development are deeper trends radically reshaping the overall business environment. Among these are a steady erosion in margins and competitiveness in many, if not most, of China’s industrial and service economy. There are few sectors and few companies that are enjoying growth and profit expansion to match last year and the years before.

China’s consumer market, while healthy overall, is also becoming a more difficult place for businesses to earn decent returns. Relentless competition is one part. As problematic are rising costs and inefficient poorly-evolved management systems.  From a producer economy dominated by large SOEs, China is shifting fast to one where consumers enjoy vastly more choice, more pricing leverage and more opportunities to buy better and buy cheaper. Online shopping is one helpful factor, since it allows Chinese to escape from the poor service and high prices that characterize so much of the traditional bricks-and-mortar retail sector. It’s hard to find anything positive to say about either the current state or future prospects for China’s “offline economy”.

Meanwhile, more Chinese are taking their spending money elsewhere, traveling and buying abroad in record numbers. They have the money to buy premium products, both at home and abroad. But, too much of what’s made and sold within China, belongs to an earlier age. Too many domestic Chinese companies are left manufacturing products no longer quite meet current demands. Adapting and changing is difficult because so many companies gorged themselves previously on bank loans. Declining margins mean that debt service every year swallows up more and more available cash flow. When the economy was still purring along, it was easier for companies and their banks to pretend debt levels were manageable. In 2015, across much of the industrial economy, the strained position of many corporate borrowers has become brutally obvious.

These are a few of the broad themes discussed in our latest research report, “China 2015 — China’s Shifting Landscape”. To download a copy click here.

Inside, you will not find much discussion of GDP growth or the stock market. Instead, we try here to illuminate some less-seen, but relevant, aspects of China’s changing business and investment environment.

For those interested in the stock market’s current woes, I can recommend this article (click here) published in The New York Times, with a good summary of how and why the Chinese stock market arrived at its current difficult state. I’m quoted about the preference among many of China’s better, bigger and more dynamic private sector companies to IPO outside China.

In our new report, I can point to a few articles that may be of special interest, for the signals they provide about future opportunities for growth and profit in China:

  1. China’s most successful cross-border M&A ever, General Mills of the USA acquisition and development of dumpling brand Wanchai Ferry (湾仔码头), using a strategy also favored by Nestle in China
  2. China’s new rules and rationale for domestic M&A – “buy first and pay later”
  3. China’s most successful, if little known, recent start-up, mobile phone brand OnePlus – in its first full year of operations, 2015 worldwide revenues should reach $1 billion, while redefining positively the way Chinese brand manufacturers are viewed in the US and Europe
  4. Shale gas – by shutting out most private sector investment, will China fail to create conditions to exploit the vast reserves, larger than America’s, buried under its soil?
  5. Nanjing – left behind during the early years of Chinese economic reform and development, it is emerging as a core of China’s “inland economy”, linking prosperous Jiangsu and Shanghai with less developed heavily-populated Hubei, Anhui, Sichuan

We’re at a fascinating moment in China’s story of 35 years of rapid and remarkable economic transformation. The report’s conclusion: for businesses and investors both global and China-based, it will take ever more insight, guts and focus to outsmart the competition and succeed.

 

China First Capital Interview: Cashing in and cashing out — China Law & Practice

1 Comment / May 7, 2015

 

China Law & Practice

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Peter Fuhrman, CEO of China First Capital, explains how the country’s private equity market has struggled with profit returns and the importance of diversified exit strategies. He also predicts the rise of new funds to execute high-yield deals

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Date: 05 May 2015

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What is China First Capital?

China First Capital is an investment bank and advisory firm with a focus on Greater China. Our business is helping larger Chinese companies, along with a select group of Fortune 500 companies, sustain and enlarge market leadership in the country, by raising capital and advising on strategic M&A. Like our clients, we operate in an opportunity-rich environment. Though realistic about the many challenges China faces as its economy and society evolve, we are as a firm fully convinced there is no better market than China to build businesses of enduring value. China still has so much going for it, with so much more growth and positive change ahead. As someone who first came to China in 1981 as a graduate student, my optimism is perhaps understandable. The positive changes this country has undergone during those years have surpassed by orders of magnitude anything I might have imagined possible.

After a rather long career in the US and Europe, including a stint as CEO of a California venture capital company as well as a venture-backed enterprise software company, I came back to China in 2008 and established China First Capital with a headquarters in Shenzhen, a place I like to think of as the California of China. It has the same mainly immigrant population and, like the Silicon Valley, is home to many leading private sector high-tech companies.

What is happening in China’s private equity (PE) market?

Back in 2008, China’s financial markets, the domestic PE industry, were far less developed. It was, we now can see, a honeymoon period. Hundreds of new PE firms were formed, while the big global players like Blackstone, Carlyle, TPG and KKR all built big new operations in China and raised tons of new money to invest there. From a standing start a decade ago, China PE grew into a colossus, the second-largest PE market in the world. But, it also, almost as quickly, became one of the more troubled. The plans to make quick money investing in Chinese companies right ahead of their planned IPO worked brilliantly for a brief time, then fell apart, as first the US, then Hong Kong and finally China’s own domestic stock exchanges shut the doors to Chinese companies. Things have since improved. IPOs for Chinese companies are back in all three markets. But PE firms are still sitting on thousands of unexited investments. The inevitable result, PE in China has had a disappointing record in the category that ultimately matters most: returning profits to limited partners (LPs).

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China’s central government gets serious about changing IPO rules and helping SMEs raise capital, Global Times article

Leave a Comment / December 5, 2014

globatimes

 

Govt calls for progress in IPO reform to help small firms

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By Wang Xinyuan Source:Global Times Published: 2014-11-24

 

Amid a slowing economy, the Chinese government is considering strategies to help the country’s cash-starved micro and small companies. Upcoming IPO reform is expected to offer easier access to stock market funding, but investors are concerned it could divert funds from existing stocks.

 

While China’s economy has been affected by a weakening property sector, erratic foreign demand and sagging domestic investment growth, the authorities are hoping that the country’s millions of micro and small enterprises (MSEs) can offer a source of economic energy.

The State Council, the country’s cabinet, pledged on Wednesday to lower the cost of raising funds by giving banks more flexibility to lend and removing rigid profit requirements for a firm to get listed in stock markets, among other measures aimed at making it easier for small firms to grow.

At the meeting on Wednesday, Premier Li Keqiang urged the securities regulator to speed up plans to unveil simplified rules for new IPOs.

Two days after the cabinet’s meeting, the central bank cut interest rates for the first time in two years.

While the rate cut will be of particular benefit for large State-owned enterprises, simplified IPO access is expected to make it easier for cash-starved smaller firms to raise money directly in the markets.

Under the existing IPO scheme, applicants must meet certain conditions in order to get listed in Shanghai or Shenzhen, including having made a profit for at least two consecutive years and having net profit of at least 10 million yuan ($1.63 million).

Even if they meet these requirements, IPO applicants are also subject to the review and approval procedures of the China Securities Regulatory Commission (CSRC), the securities watchdog.

The CSRC suspended its IPO reviews in late 2012 in a bid to enhance information disclosure and crack down on rampant financial fraud and insider trading.

The CSRC also wanted to lay solid foundations for a new round of IPO reform intended to diminish government intervention and establish a more efficient, market-based IPO filing system.

The regulator restarted IPO approvals in December 2013 after a 13-month hiatus.

However, the suspension had resulted in a long queue of IPO applicants. As of mid-November this year, 570 firms were waiting for their applications to be reviewed, according to media reports.

A plan for an IPO filing system with a focus on information disclosure is likely to be released by the end of 2014, the 21st Century Business Herald reported on Thursday, citing a source close to the CSRC.

Equal access

Under the new IPO registration system, the CSRC will no longer intervene in the listing process and will focus on supervision rather than review and approval, analysts said.

The system will provide access to market financing for all firms, not just those at the front of the queue for IPO approval, and the investment value shall be judged by investors, not the government, Dong Dengxin, director of the Finance and Securities Institute at Wuhan University of Science and Technology, wrote on his Weibo on Saturday.

The CSRC was not available for comment on the schedule of IPO registration reform when reached by the Global Times on Thursday.

As China tries to move up the value chain and restructure its economy, small firms have become increasingly important. They also account for more than 70 percent of the country’s jobs.

“While the IPO reforms are absolutely correct in their direction and implementation, the capital markets in China are still unable to provide the financing needed for most MSEs to continue to grow,” Peter Fuhrman, chairman and CEO of Shenzhen-based investment bank China First Capital, told the Global Times in an e-mail on Saturday.

Relatively slow approval of IPOs and the exceptionally long waiting list are seen as the major reasons for the difficult funding.

There are “thousands of Chinese MSEs with good size and profits” that are waiting to go public, said Fuhrman.

Read full article.

Alibaba grabs the IPO money but the future belongs to Jeff Bezos and Amazon China

4 Comments / October 3, 2014

Amazon China & Alibaba

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Alibaba Group should next week collect the big money from its NYSE IPO. But, Seattle’s Amazon owns the future of China’s $400 billion online shopping industry. Amazon’s China business is better in just about every crucial respect: customer service, delivery, product quality even price when compared to Alibaba’s towering Taobao business. Hand it to Jeff Bezos. While few have been watching, he is building in China what looks to me to be a better, more long-term sustainable business than Alibaba’s Jack Ma.

Amazon’s China business fits a familiar pattern. The company is often mocked for keeping too much secret, investing too much and earning too little. In China, far away from the Wall Street spotlight, Amazon has invested hugely, with a long-term aim perhaps to overtake Alibaba and become a dominant online retailer in the country. But, it has zero interest in letting its shareholders, competitors, or the world at large know what it’s doing in China. Open the company’s most recent SEC 10-K filing and there are three passing mentions of China, and nothing about the size of its business there, the strategy.

Amazon shareholders may well wake up one day and suddenly find Bezos has built for them one of the most valuable online businesses in the world’s largest e-commerce market, the only one not owned and managed by a Chinese corporation. No rickety and risky VIE structure, unlike Alibaba and virtually all the other Chinese online companies quoted in the US.  (Read damning report by US Congress investigators on these Chinese VIE companies here. )

Jeff Bezos has been in the online shopping business from its genesis, in 1994. He first got serious in China ten years later, by buying a small online shopping business called Joyo in 2004. Taobao was founded by Jack Ma a year earlier. Within three years Taobao had demolished eBay’s then-lucrative China online auction business, by making it free for sellers to list their products on Taobao. Buyers and sellers both pay Taobao zero commission. It earns most of its money from advertising. EBay China closed its doors in 2006. Since then, Alibaba has grown from about $170mn in revenues to over $6 billion in 2013. Approximately three out of every four dollars spent online shopping in China goes through Alibaba’s hands. Overall, online shopping transaction value is on track to exceed $1 trillion by the end of this decade.

online shopping China

The champagne and baijiu will flow at Alibaba next week. Meantime, Bezos will continue executing on his plan, begun in earnest around 2012, to first gain on Taobao, and one day outduel it in China. How? To buy from Amazon China is to see Bezos’s mind at work. He has clearly assessed Taobao’s pivotal weaknesses, and is targeting them with precision.

Taobao has done phenomenally well. But, it is much the same business today as a decade ago. It is mainly a raucous collection of individual sellers where counterfeit, used-sold-as-new or substandard goods are rife. Everything is ad hoc. Sellers can appear and disappear overnight. They charge whatever they like to ship you your merchandise. Try to return things and it can be anything from complicated to impossible. Most payments are processed by Alipay, a business with similar ownership to Alibaba, but not fully consolidated as part of the IPO. Alipay tries to act like an impartial escrow service between Chinese buyers and sellers who too often seem to be out to try to cheat one another.

Taobao is a product of its time, a China where getting stuff cheap, of whatever origin, authenticity and quality, was paramount. It’s also been a great way to create an army of small entrepreneurs in China, eight million in total, with their own shops selling merchandise to over 200 million different individual customers on Taobao. But, Chinese are much richer and more discriminating today than ten years ago. They are getting richer by the day. The larger trends all point in Amazon’s favor.

Here’s why. When you buy things on Amazon China, you mainly purchase direct from Amazon, not from individual sellers. As in the US, Amazon China sells a full range of merchandise not just books. While it has far fewer items for sale than Taobao, it does many things that Taobao cannot. First, it has its own nationwide delivery service. Where I am in Shenzhen, I get delivery the next morning from a guy in an Amazon shirt with his electric motorcycle parked on the sidewalk in front of my building. You can either pay online by credit card, or pay the delivery guy in cash, COD. Delivery is free and reliable. Parcels are professionally packaged in Amazon boxes and generally arrive in mint condition. It’s a limousine service compared to Taobao.

Stuff ordered on Taobao can take days to arrive, and is sent using any of a group of different independently-owned parcel delivery companies. They don’t accept returns, or cash, and often in my experience as a Taobao customer for the last five years the parcels arrive pretty badly roughed up. The Taobao sellers do their own packaging, sometimes good and sometimes no, usually with boxes rescued from the trash, then call whichever parcel company offers them the cheapest rate. The seller usually takes a mark-up since delivery on Taobao is generally not included.

Amazon China is putting its brand and reputation behind everything it sells. This provides a quality guarantee that no individual seller on Taobao can match. I’ve also found over the course of the last year that prices for similar items are often now cheaper on Amazon than on Taobao. How so? For one thing, unlike the Taobao army, Amazon can use its buying power to extract lower prices and better payment terms from its suppliers. Taobao has a subsidiary business called TMall, where major brands directly sell their products. Here at least there should be no worries about the quality and authenticity of what’s being sold. But since each brand manages its own store on TMall, the prices are often higher than on Amazon China. Delivery is also less efficient, in my experience.

What does Taobao still do better than Amazon China? Its website seems a bit easier for Chinese to navigate than Amazon China’s, which looks and acts a lot like the main Amazon website designed and managed in Seattle.

As Bezos’s shareholders know well and occasionally grumble about, he loves spending money on warehouses, shipping technology and other expensive infrastructure. The China business is a marvel of its kind, a kind of “Bezosian” tour de force. The scale and complexity of what Amazon China are doing is formidable. Bezos started and prospered originally with a no inventory business model, letting outside wholesalers hold and so finance the inventory of books he was selling online.

In China, Amazon must stock huge inventories to get products delivered to customers overnight. Where these facilities are and how much Amazon has spent is beyond knowing. Anything I buy on Amazon China — most recently three books, an electronic garlic-mincer and some ceramic carving knives — is delivered to me next day, within about 15 hours of when I ordered it. In a country China’s size, where moving things around long-distance by truck as UPS and Fedex do in the US is difficult and expensive, Amazon has apparently invested in a large nationwide distributed network of warehouses to hold all this inventory. Whether these are owned by Amazon or third parties is also not disclosed. But, it all works smoothly. I get what I order quickly and efficiently, direct from Amazon’s own liveried delivery team, at prices Taobao can’t match.

Every delivered package drives home the message how much faster, cheaper and more reliable Amazon China is compared to Taobao. Try us once, Bezos seems to be saying here in China, and you’ll try us again.

Amazon China delivery guyCan Amazon China be making any money here? My guess is No, that the current operation in China is a big money sink. How big? China’s other big online shopping business, JD.com, which went public earlier this year and has a business model more like Amazon China than Alibaba’s, is losing money every quarter. (Nonetheless, it has a current market cap of $40bn.)

Alibaba, by contrast, is making money hand-over-fist, Rmb8 billion ($1.3bn) in net income the last quarter of 2013. To get noticed, those eight million individual Taobao sellers, as well as TMall brands, need to pay more and more to Taobao for ads and preferential placement.

Longer term, though, the Taobao ad-supported model looks ill-adapted to where China is headed. Traditional store retailers in China are getting slaughtered by online competitors. Among those online players, it seems likely business will shift to those that can guarantee quality, authenticity, easy product returns and efficient next-day-delivery. That describes Amazon.

One reason it’s crazy to bet against Bezos is he has shown no compunction about using shareholder money to build a business that can only start to make real money in ten maybe fifteen years. Jack Ma has no such luxury, especially now that Alibaba will be quoted on the NYSE. Alibaba is not likely to attract the kind of patient shareholders drawn to Amazon.

This is perhaps one reason why Ma has been out spending a huge pile of Alibaba money buying into all kinds of businesses to tack onto Alibaba. These include US car service Lyft, messaging business Tango, and all sorts of domestic Chinese businesses, including a big slice of China’s Twitter, Weibo, the digital mapping company AutoNavi,  16.5% of China’s YouTube knockoff, NYSE-quoted Youku and a Hong Kong-quoted film studio that seems to have been cooking its books. He also bought control of a professional soccer team in China, hoping to upgrade the much-maligned image of the domestic game. Add it up and it looks like even Ma isn’t fully convinced Taobao will be able to keep spinning money for years to come.

His most successful recent venture begun last year is an online money management business called Yuebao that pays Chinese savers about 4% on deposits, compared to the less than 0.5% offered by local Chinese banks. As of early September, it had Rmb574 billion, nearly $100 billion, under management. This business is not included in the Alibaba entity going public in New York. That points up another worrying aspect of Jack Ma’s business style. He has shown a proclivity to put some of the more valuable assets into vehicles that only he, rather than the shareholder-owned company, controls. Yahoo! and Japan’s SoftBank have some bitter direct experience with this.

How far can Bezos go in China? After all, he doesn’t speak Chinese and doesn’t seem to visit China all that often. Can a kid from a Miami high school really build a better China business than scrappy Hangzhou-native Jack Ma? One pointer is that the most successful traditional retailers are now mainly foreign-owned and managed. Domestic retailers couldn’t adapt to this new era of rampant low-price online competition. But, Zara, H&M and Sephora are all thriving here. They, too, focused on details often overlooked here, like good customer service, no-questions-asked return policy, competitive prices and great merchandising.

Alibaba’s market cap next week, after its biggest-of-all-time IPO, may temporarily overtake Amazon’s, at $160 billion. But, make no mistake, Amazon will likely prove the more valuable business over time, both in China and globally.

 

China juices liquidity, and risk, at OTC exchange — Reuters

Leave a Comment / June 24, 2016

Reuters

China juices liquidity, and risk, at OTC exchange

By Pete Sweeney

SHANGHAI August 22 Thu Aug 21, 2014 5:10pm EDT

(Reuters) – Chinese brokerages will start making markets next week on China’s New Third Board, its leading over-the-counter (OTC) exchange but one long derided as a dead-end market populated by small little-known, opaquely managed firms.

The move has revitalized interest and trading volumes have exploded, but analysts warn of significant risk.

Most of the 66 Chinese brokerages so far approved to make markets – a business that requires deep cash reserves and sophisticated risk management skills – have little experience.

Market makers quote both a buy and sell price and guarantee share availability by holding shares themselves in inventory, which requires careful real-time management.

For brokerages it means extra profits, while China’s policymakers hope the liberalization will boost liquidity in an exchange that can provide capital for small innovative firms, needed for the next phase of economic expansion.

But, analysts fear that brokerages inexperience coupled with inadequate disclosure by listed companies could led to trouble for an exchange already saddled with image problems.

“Like all OTC markets – including… America’s Bulletin Board and Pink Sheets – China’s Third Board suffers from inherent fundamental flaws,” said Peter Fuhrman, chief executive at China First Capital.

“Liquidity and valuations are persistently low and disclosure is spotty. If it was designed to be a solution to the problem of erratic mainstream IPO policy and approvals on China’s main Shenzhen and Shanghai stock exchanges, the Third Board must be judged a major disappointment.”

Regardless of critics, trading volumes on the exchange soared almost 700 percent in May when Chinese media first reported the advent of market-makers, ChinaScope Financial data shows. Foreign investors are unable to trade on the exchange.

A Reuters analysis of daily data from the National Equities Exchange and Quotations (NEEQ), which runs the New Third Board, shows that August volumes are set to surpass May’s record. Transactions worth 1.16 billion yuan ($188.63 million), as of Aug. 19, were nearly double July’s total, while the volume of shares traded has more than tripled month-on-month.

SMALL CAP CELEBRATION

Smaller private companies in China are the country’s biggest aggregate employers and generators of GDP, but they have difficulty getting bank loans and even more difficulty getting regulatory approval to list on major markets or issue bonds.

However, while dozens of local governments have created OTC markets to help match companies with investors, the lack of market makers and lack of a clear upgrade path to major exchanges has caused most firms and investors to steer clear.

But that may be about to change.

“The expectation is that the Third Board can be an entree onto the growth enterprise board for select small companies,” said Brian Ingram, chief investment manager at Russell Ping An Investment Management.

“If the board does serve that purpose, it’s likely to see pretty rapid growth, and the catalyst for that growth is the fact that regulators are allowing brokerage houses to serve as market makers.”

Brokerages hope it will boost in profits, something they need badly having struggled since 2010 as investors steadily switched out of Chinese stocks, among the world’s worst performers, in favor of housing and high-yielding wealth management products.

SMALL-CAP FEEDING FRENZY

Chinese investors enthusiastically trade small, volatile tickers listed on Shenzhen’s ChiNext growth board, so some predict a revitalized OTC board will attract similar speculative interest, further supporting liquidity.

However, sustained interest from both investors and companies depends on whether regulators formally commit to allowing companies on the New Third Board upgrade to ChiNext.

“We’re now considering listing on the New Third Board, but we are waiting for policy confirmation that we can upgrade to ChiNext,” said Cui Lijun, deputy general manager at robotics firm LEN in Shenzhen.

Similar experiments have disappointed in the past, such as the hard-currency-denominated “B-share” board. Speculators bought B-shares hoping they would ultimately be upgraded to yuan-denominated A-shares, but in the end only a few companies were allowed to transfer, leaving the rest stranded.

CALLS FOR CAUTION

The chequered history of OTC markets in China and abroad, especially with regards to disclosure standards, also has many calling for caution.

In the late 2000s, small Chinese companies began listing on American OTC boards, and some managed to upgrade to major exchanges such as NASDAQ. But many were subsequently found to be riddled with accounting irregularities, causing a swathe of delistings.

Given this history, it is unclear whether regulators want to expand the aggregate OTC market or consolidate it.

Out of all of China’s 26 OTC markets, the New Third Board is the only one that companies from anywhere in China can list on, and it will now be the only one where making markets will be allowed.

Some analysts said that this means the government may be elevating the Third Board, so it can then kill off the rest.

But Zhang Yunfeng, the head of Shanghai’s rival OTC market, said in an interview published in China’s Securities Times on Wednesday that he doesn’t feel threatened.

“I’m not optimistic about the market making institution … if there’s not enough base liquidity, market making will have a hard time enabling market performance.”

www.reuters.com/article/2014/08/21/us-china-markets-otc-idUSKBN0GL26920140821

Download PDF version.

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Chinese PE Firms Too Tech-Focused: Report. AsianInvestor

Leave a Comment / December 5, 2014

AI

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Chinese PE firms too tech-focused: report

By Elva Muk | 28 July 2014

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Company valuations are being pushed up as PE firms chase the same targets, and market domination by big players like Alibaba is squeezing profit, says China First Capital.

Spurred by the success of the likes of Tencent and Alibaba, Chinese private equity and venture capital firms have become too focused on technology and e-commerce investments, argues a new report.

Nearly all publicly announced deals this year have been in the technology sector, says the China Private Equity 2014 report from China First Capital, a private capital markets advisory firm. They include online shopping sites and mobile travel, game and taxi-booking services.

Though China has restarted its initial public offering process after a hiatus of more than a year, US listing also provides an effective way for PE firms to exit their investments. Chinese internet and mobile companies Zhaopin, Cheetah Mobile, Sina Weibo and Qihoo 360 have already floated in the US market this year.

Though Tencent and Alibaba are shining examples of success, the investment outlook for newly established technology companies may not be as rosy, the report says. These firms do not enjoy a technological barrier to entry and rely “on the same prayer-for-low-profitability outcome: a purchase down the road by China’s two internet leviathans, Tencent or Alibaba”.

But China First Capital forecasts that the duo will soon lose their appetite for buying smaller Chinese internet firms.

Moreover, domination by the major players has squeezed the growth potential of newcomers. Alibaba commands close to 50% market share of the country’s online shopping in terms of transaction volume, while Tencent is similarly dominant in online gaming. Almost all the money goes to these two firms, the report notes.

Further, the investment landscape in China is less dynamic than some elsewhere. The US has a greater number of venture capital trade buyers for successful VC-backed companies, and less monopolistic internet and mobile industries and a richer early adaptor market to tap, the report notes.

In China over the past two years, PE firms have invested heavily in Chinese shopping sites that follow a model similar to Groupon. However, some projects have lost money because monetising the sites has proved difficult.

Another obstacle in China for private equity in building up investment is the high cost of acquiring clients. In most VC-backed companies in the US, the head of business development is responsible for generating growth at the cheapest cost.

This approach is uncommon in China. A typical method of acquiring customers in the mainland is to pay for a high-ranked listing on search engine Baidu, which handles over 60% of search requests in the country.

“The ‘pay to play’ rules of China’s internet [industry] lead to companies taking lots of expensive shortcuts, often burning a lot of PE and VC firms’ cash,” the report said.

Further, PE firms are chasing the same investment themes and companies, resulting in rising valuations. “It is an ongoing example of inadequate diversification by industry or stage,” it added.

China’s PE capital raised has grown five-fold to over $100 billion since 2005, while the number of firms has grown to 1,000.

– Haymarket Media Limited. All rights reserved.

http://www.asianinvestor.net/News/388932,chinese-pe-firms-too-tech-focused-report.aspx

PDF Version

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Alibaba files for IPO in US — China Daily article

Leave a Comment / May 8, 2014

China Daily

 

 

Updated: 2014-05-07 06:56

By MICHAEL BARRIS in New York (chinadaily.com.cn)

Alibaba files for IPO in US

Alibaba Chairman and Non-executive Director Jack Ma participates in a teleconference in Hong Kong in this October 22, 2007 file photo, one day before its initial public offering in the territory. [Photo/Agencies]

Chinese e-commerce giant Alibaba Group Holding officially filed on Tuesday to go public in the US in what could be the largest initial public offering ever.

A regulatory filing gave a $1 billion placeholder value for the offering, but the actual amount is expected to be far higher, possibly exceeding $20 billion and topping not only Facebook’s $16 billion 2012 listing, but Agricultural Bank of China Ltd’s record $22.1 billion offering in Shanghai and Hong Kong in 2010.

Alibaba, founded by former English teacher Jack Ma in a Hangzhou apartment, and its bankers have been moving to throw their own shares behind the IPO, analysts have said.

In its filing Alibaba gave no date for the proposed IPO or whether it would be on the New York Stock Exchange or Nasdaq. It cited its advantageous placement in a nation in which e-commerce is fast becoming a way of life, as Chinese consumers turn to the Internet to buy innumerable items. But Alibaba’s prospectus cited statistics showing that the market hasn’t been fully tapped. Just 45.8 percent of China’s population used the Internet, while 49 percent of customers shopped online.

Often described as a combination of eBay and Amazon, Alibaba handled $240 billion of merchandise in 2013. With more than 7 million merchants, it has more than $2 billion in revenue and profit of more than $1 billion.

Alibaba’s sheer size could weigh on the stock price of US rival Amazon.com if the Chinese company’s shares are added to indexes and portfolios targeting e-commerce and related sectors, analysts said.

“Amazon simply doesn’t measure up to the size of Alibaba’s earnings and earnings growth rate,” analyst Robert Wagner wrote.

Shares aren’t expected to begin trading for several months, as the US Securities and Exchange Commission reviews Alibaba’s offering materials and the company promotes its prospects to institutional investors.

The offering managers are Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Morgan Stanley and Citigroup.

Ma, who has described the challenge of providing what he calls personal business as “my religion”, is Alibaba’s biggest individual shareholder, with an 8.9 percent stake.

Alibaba’s announcement continues a flurry of IPO filings by Chinese technology companies. Internet security application developer Cheetah Mobile is expected to go public on the New York Stock Exchange on Thursday and is expected to raise $153.75 million to $178.35 million. Three weeks ago, Weibo Corp, the Chinese micro blogging service owned by Sina Corp and Alibaba Group Holdings Ltd, raised $285.6 million in a Nasdaq IPO, while real-estate listings website Leju Holdings Ltd raised $100 million in an initial offering on the NYSE.

“The key question for China is how much new money, if any, Alibaba will raise in this US IPO,” Peter Fuhrman, chairman and CEO of China First Capital, told China Daily.

“If all the cash goes to Japan’s Softbank and US’s Yahoo, then it’s hard to see how Alibaba, its customers and the hundreds of millions of Taobao-addicted Chinese consumers will benefit from the IPO.” US web-portal company Yahoo is a 24-percent Alibaba shareholder, while Japan’s Softbank has a 37-percent stake.

http://usa.chinadaily.com.cn/business/2014-05/07/content_17490099.htm

WH Group Hong Kong IPO Goes Belly Up – Leaving Wall Street’s Most Famed Investment Banks and Some of Asia’s Biggest PE Firms at an Embarrassing Loss

Leave a Comment / May 7, 2014

WSJ Shuanghui WH Group failed IPO

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There will be an awful lot of embarrassed financial professionals sulking around Hong Kong and Wall Street today. The reason: a crazy IPO deal financially-engineered by a group of 29 big name investment banks, led by Morgan Stanley, together with several large China and Asian-based PE firms including China’s CDH and Singapore’s Temasek Holdings failed to find investors. Their pig’s ear didn’t, as they promised, turn into the silk purse after all. The planned IPO of WH Group has been aborted.

WH Group was created by the banks and PE firms to hold the assets of American pork producer Smithfield Foods bought last year in a leveraged buyout. The other asset inside of WH Group is a majority shareholding in China’s largest pork company Henan Shuanghui Investment & Development.

I was one of the few who actually called into question almost a year ago the logic as well as the economics of the deal. You can read my original article here.

There weren’t a lot of other doubters at the time. The mainstream financial press, by and large, went along with things, accepting at face value the story provided to them by Morgan Stanley, CDH and others. Over the last few months, as the now-failed IPO got into gear in anticipation of closing the deal around now, the press kept up its steady reporting, not raising too many tough questions about what were obviously some glaring weak points – the high debt, the high valuation, the crazy corporate structure that made the deal appear to be what it wasn’t, a Chinese takeover of a big US pork company.

I have no special interest in this deal, since me and my firm never acted for any of the parties involved, nor do I own any shares in any of the companies involved. I just couldn’t get over, in reading the SEC documents filed at the time of the takeover, the brazenness of it, the chutzpah, that these big institutions seemed to be betting they could repackage a pound of sausage bought in New York for $1 as pork fillet and sell it for $5 to Hong Kong investors and institutions.

In other words, saying at the time it looked like the whole thing rested on a very shaky foundation was a reasonable conclusion for anyone who took the time to read the SEC filings. Instead, mainly what we heard about, over and over, was that this was (wrongly) China’s “biggest takeover of a US company,” a “merger between America’s largest pork producer and its counterpart in the world’s largest pork market.”

Morgan Stanley, CDH, Temasek and the others got a little too cocky. The original Smithfield “take private” deal last year went through smoothly. They moved quicker than originally planned to get the company re-listed in Hong Kong. Had they pulled it off, it would have meant huge fees for the investment bankers, and depending on the share price, a juicy return for the PE firms, most of whom had been stuck holding the shares in Henan Shuanghui Investment & Development for over seven years. First came word last week they wanted to cut back by 60% the size of the IPO due to the hostile reception from investors during the road show phase. Then the IPO was suddenly called off late on Tuesday, Hong Kong time.

One of the questions that never got properly answered is why these PE firms didn’t sell their Shuanghui shares on the Chinese stock market, but held them since IPO, without exiting. That’s unusual, especially since Shuanghui’s shares have traded well above the level CDH and others bought in at. I wasn’t in China at the time, but that original investment did not cover itself in praise and glory. Almost immediately after the PE firms went in, providing the capital to allow the state-owned Shuanghui to privatize itself in 2006, the rumors began to circulate that the deal was deeply corrupt, and for reasons never explained, was structured in a way where the PE firms did not have a way to exit through normal stock market channels.

The Smithfield acquisition never made much of any industrial sense. The PE firms that now own the majority (mainly CDH, Temasek, New Horizon, but also including Goldman Sachs’ Asia PE arm ) have no experience or knowledge how to run a pork business in the US. In fact, they don’t know how to run any business in the US. The Shuanghui China management, which is meant now to be serving two separate masters, simultaneously running the Chinese company and its troubled American cousin, similarly don’t know a hock from a snout when it comes to raising and selling pork in the US. This is, was and will remain the main business of Smithfield. Not exporting pork to China. How, when and why these US assets can be listed in Asia must certainly now count as a mystery to all of the big-name financial institutions involved, including Bank of China, which lent billions to finance the takeover last year, as did Morgan Stanley itself.

So, now we have this sorry spectacle of the PE firms, together with partners, having seemingly thrown more money away in a failed bid to rescue the original Shuanghui investment from its unexplained illiquidity. The WH Group IPO failure is also a stunning rebuke for the other PE-backed P2P take private deals now waiting to relist in Hong Kong. (Read here, here, here.) Smithfield, while no great shakes, is the jewel among the rather sorry group of mainly-Chinese companies taken private from the US stock exchange with the plan to sell them later to Hong Kong-based investors via an IPO.

This was among the most bloated IPOs ever, with 29 investment banks given underwriting mandates to sell shares. ( The IPO banks included not only Morgan Stanley, but also Citic Securities, Goldman Sachs, UBS, Barclays, Credit Suisse, JP Morgan, Nomura, Citigroup, Deutsche Bank.) All that expensive investment banking firepower. Result: among the most expensive IPO duds in history.

For the PE consortium that owns WH Group, they will have already likely lost over USD$15mn in LP money on legal, underwriting and accounting fees on this failed IPO. This is on top of a whopping $729mn fees paid by the PE firms for what are called “one-off fees and share-based payments” to acquire Smithfield. The subsequent restructuring ahead of IPO? Maybe another $100mn. If or when the WH Group IPO is tried again, the fees will likely be at least as high as the first time around. In short, the PE firms are already close to $1 billion in the red on this deal, not including interest payments on all the debt.  Smithfield itself remains lacklustre. Its net profit shrank 50% during the fiscal year leading up to the buyout.

With no IPO proceeds anywhere on the horizon, the issue looming largest now for the PE firms: is WH Group generating enough free cash to service the $7 billion in debt, including $4 billion borrowed to buy sputtering Smithfield? If not, next stop is Chapter 11.

By contrast, now feeling as delighted as pigs in muck are the mainly-US shareholders who last year sold their Smithfield shares at a 31% premium above the pre-bid price to the Chinese-led PE group. It doesn’t offset by much the US trade deficit with China, which reached a new record last year of $318 billion. But these US investors also get the satisfaction of knowing they have so far received the far better end of a deal against some of the bigger, richer financial institutions in Asia and Wall Street.

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WH Group under scrutiny in wake of cancelled Hong Kong IPO — Financial Times

Leave a Comment / May 1, 2014

FT–

FT logo

WH Group under scrutiny in wake of cancelled Hong Kong IPO

By Josh Noble in Hong Kong

April 30, 2014 3:55 pm

Shuanghui

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WH Group’s ditched Hong Kong listing has drawn fresh scrutiny over the structure and rationale behind its $7bn takeover of Smithfield Foods – the largest ever US acquisition by a Chinese company.

The Sino-US pork producer, now the leader in both markets, abandoned its planned initial public offering this week, having failed to win over investors – despite alreadycutting the deal size in half.

WH Group – formerly known as Shuanghui International – blamed deteriorating market conditions, while analysts pointed to poor sentiment towards China and the outbreak of a deadly pig virus in the US.

Though investors did show interest, many were “simply not on the same page as the company” when it came to valuation, said one person with knowledge of the sale process.

However, some have raised doubts over WH Group’s longer-term prospects, and questioned the thinking behind the Smithfield buy. WH Group had pitched itself as a global leader tapping rising Chinese consumption, but investors instead responded to two separate businesses – one in the US and one in China – bolted together and creaking with debt, say bankers.

“It’s like buying a house, ripping out the bathrooms and kitchen, and trying to flip it for a premium six months later,” said one senior equity banker.

Investors also expressed concerns that a trimmed deal would simply store up trouble down the road, by raising only a slice of the money needed to pay off debts. Further capital raising and shareholder sales would then be inevitable – creating a major overhang for a company seeking a valuation in line with established US peers.

The original case for purchasing Smithfield was to create one international company that could capitalise on cheap pork in the US by selling it into China, the world’s biggest consumer of the meat. Smithfield’s higher-margin pork products – such as ham and sausages – were also seen as a neat way to gain exposure to rising wealth and changing eating habits in China.

When announcing the deal in September last year, Wan Long, now chairman of WH Group, pointed to numerous advantages of combining the companies.

“Together we look forward to utilising our individual strengths – including Shuanghui’s extensive distribution network in China, and Smithfield’s leading production and safety protocols – to provide safe, high-quality products to consumers worldwide,” he said at the time.

But the company has yet to prove to investors that its plans will work, having completed the takeover only six months before attempting to list. Management has not yet been integrated, while Smithfield products are still some months away from arriving on Chinese supermarket shelves.

WH Group borrowed about $4bn to finance its purchase of Smithfield, much of which is not due to be repaid for years. Most of it was lent by Bank of China, although a chunk of about $1.5bn – originally a bridge loan from Morgan Stanley – has now been placed with US investors as five-year and seven-year debt. The company had sought a listing to help pay off some of its loans, largely because of the chairman’s own distrust of debt, according to two people with knowledge of the process.

Though the debt was borrowed at relatively cheap rates, the failure to attract new equity investment leaves the company with tens of millions of dollars a year of debt-servicing costs, and leaves private equity investors trapped for the foreseeable future.

Peter Fuhrman, chief executive of advisory firm China First Capital, describes the episode as one of the “most expensive IPO duds in history”, and believes the Smithfield deal was actually an attempt by private equity investors to bulk up the company to help provide an exit to their holdings in the original China-only business.

Those investors include Goldman Sachs, Temasek and New Horizon. However, CDH Investments, a Chinese private equity house, is by far the largest outside shareholder, and thought to have been a key driving force behind the deal.

“WH Group was created by the banks and PE firms to hold the assets of American pork producer Smithfield Foods bought last year in a leveraged buyout,” Mr Fuhrman wrote on his blog. “Now we have this sorry spectacle of the PE firms, together with partners, having seemingly thrown more money away in a failed bid to rescue the original Shuanghui investment from its unexplained illiquidity.”

Those familiar with the cancelled float say that WH Group is almost certain to return at a later date, with a new deal likely to involve a far smaller syndicate than the 29 bookrunners it hired first time round.

Attention will now shift to the company’s first-half earnings. Last year WH Group made a net loss of $67m, largely caused by share-based awards given to two executives worth almost $600m, according to its listing prospectus. Shares in the Chinese business – listed in Shenzhen under the name Henan Shuanghui Investment & Development – are down by a quarter so far this year.

PDF version

 

http://www.ft.com/intl/cms/s/0/7e8723fe-d03b-11e3-af2b-00144feabdc0.html

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China’s New IPO Regime — manipulation or emancipation? — Reuters

Leave a Comment / June 24, 2016

Reuters

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In English we use the phrase ” bee in one’s bonnet” to explain someone with an obsession for a particular point of view. In Chinese, a similar idiom is 挥之不去, meaning you can’t wipe out the stain.

Have a  look at this article today by Reuters, about the IPO process in China. To me, the reporters started off this story with a bee in their hats, that China’s domestic IPO industry remains a nest of corruption, manipulation and ominous doings by the regulator, the CSRC. They found someone to quote, and then asked me for my opinion. I shared it across several emails. As you’ll see, I end up being quoted in the article providing something of an antidote to all the negativity. I don’t think, to switch back to the Chinese,  I quite wiped away the stain.

Here’s the story that didn’t get reported. In the last five weeks, China’s domestic stock markets had 48 successful IPOs. That is exactly 48 more than China had in all of 2013, and ahead of the successful IPOs so far this year in Hong Kong and the US. In my view, China is on track, as I said in one of those emails to the Reuters reporter, “to shatter all worldwide records for number of IPOs in a year and money raised.”

That’s big news. Instead, the article focuses on a whole lot else that all boils down to dark mutterings, but not a lot of facts, suggesting that insider trading  is or may become rife; that there’s some form of “moral hazard” at work here. Hard to refute. Equally hard to confirm.

The one example cited, of the cancelled Jiangsu Aosaikang, is said by a source to be “most heavily intervened IPO in the history of China”. IPOs, for those keeping score, get pulled all the time, everywhere, most often because investors wouldn’t commit to buying all the shares on offer. What happened with the Jiangsu Aosaikang IPO no one can say for sure. But, the quote is just silly.

Until two months ago, all China IPOs involved a level of direct, disclosed, intensive intervention by the CSRC that covered not only the IPO offering price, but included too the CSRC making decisions on which Chinese companies should IPO, when, with what level of profits. This was intervention on a grand, intentional and absolutist scale.

We’re only in the second month of the new IPO regime in China. Things might degenerate. The CSRC and market participants like underwriters are still feeling their way forward. But, there’s ample room for optimism here: a highly-damaging IPO embargo is over, Rmb 30 billion  ($5 bn) has been raised, and there’s clearly investor appetite for more new issues. –

Reuters

Private Equity in China 2014: A Dialogue

1 Comment / January 19, 2014

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PE in China is changing. But, from what and into what?

Over the last week, I had an email discussion with a managing director in China of one of the world’s five largest private equity firms. He wrote to tell me about the fund’s recent change in China strategy, which then triggered an email dialogue on the specific challenges his firm is trying to overcome, and the larger tides that are shaping the private equity industry in China.

I’ll share an edited version here. I’ve taken out the firm’s name and any references that might make it identifiable.

Think it’s easy to be a private equity boss in China, to keep your job and keep your LPs happy? It’s anything but.– – –

PE Firm Managing Director: Peter, I want to share some change in our fund strategy with you and get your opinion on it.

We have optimized our investment strategy for our US$ fund. We will focus more on late-stage companies that can achieve an IPO within 1-2 years and exit/partial exit perhaps 3-4 years or less. Total investment amount is still $30-80M but we prefer larger deal sizes within the range. Since these are high quality companies, we have lowered our criteria and is willing to be more competitive and pay higher valuation and take less % ownership (minimum 4-5% is still OK). We can also buy more old shares and participate in small club deals as long as the minimum investment size is met.

We are also willing to work with high quality listed companies in terms of PIPE/CB. In sum, our strategy should be more flexible and competitive versus before.

Me: Thanks for sending me the summary on the new investment strategy. You could guess I wouldn’t just reply, “sounds fine to me”.

Here’s my view of it, after a day’s thought. If I didn’t know it was from [your firm], or didn’t focus on the larger check size, I’d say the strategy was identical to every RMB PE firm active in China, starting with Jiuding and then moving downward. That by itself is a problem since in my mind, [your firm] operates in a different universe from those guys — you are thoroughly professional, experienced, global, proper fiduciaries. Maybe that’s your opportunity, to be the ” thoroughly professional, experienced, global, proper fiduciary” version of an RMB fund?

Other problem is, unless your firm is even smarter and more well-connected in Zhongnanhai than I think, no one can have any real idea at this point which Chinese companies, other than Alibaba Group,  can gain an IPO in next two years. The English idiom here is “making yourself a hostage to fortune”. In other words, the only way a PE could consistently achieve the goal of “IPO exits within 24 months” is based more on luck than planning and deal execution.

If you asked me, I’d think the way to frame it is you will opportunistically seek early exits, but will focus always on companies where you have confidence EV will increase by +30% YOY over short- and medium-term, in part due to the money and know-how you provide. It’s kind of a hedge, rather than just hoping IPO exits will come roaring back after almost two years with basically zero Chinese IPOs.

The good news for you and for me is that China has so many great companies, great entrepreneurs that all of us can “free ride”, to some extent, on their genius and ability to generate growth and wealth.

PE MD: Thanks for the detailed message and for thinking so hard to help us.

First let me explain why the changes were made. Through extensive recent discussion with limited partners, it appears that a hybrid fund with small early stage, mid-sized growth stage and larger sized late stage or PIPE is not what LPs want as they are in the business of allocating funds to a variety of focused managers rather than just put the money to a single fund doing it all. For example, it could allocate a small portion of its capital to Sequoia or Qiming for early stage and pray they can get a huge return back in five years. For other (major) part of their allocation, they desire some fund which can focus more on IRR increase of Multiple of Capital.

I think this is where we are attempting to position our latest fund. Even though our returns are decent, our previous funds took too long to return distributions and result in lower IRRs.

As you know, my firm has [over $100 billion] AUM. Although the company including the Founder is extremely supportive of our fund, we have to do more to make our fund relevant to the firm financially. Therefore, we need to focus on bigger/latter stage project which can allow us to deploy/harvest capital more quickly than before (3-4 years versus 5-7 years) and building up more AUM per investment professional to reach at least the average for the firm.

Doing many small projects ($10-20 million) has also put a very high administrative burden/cost on our back-office. While the strategy means that we will go in a little bit later stage, taking a smaller-stake sometimes and perhaps pay a higher valuation (since the companies are more expensive as risks are lower closer to liquidity), it doesn’t change our commitment to each investment. In fact, due to the reduced number of investment, we can focus our value creation efforts on each one more. This is very different than the shoot and forget method of Jiuding.

It is true having a smaller stake will reduce our influence and perhaps reduce our ability to persuade the founder to sell in case an IPO is impossible. However, a smaller stake means it is more liquid after IPO and we can be more flexible in selling the stake pre-IPO to another PE. Of course we are not explicitly targeting IPO in 24 month but we are trying to be as late stage as possible while meeting our IRR stand. We do have some idea of what kind of company can IPO sooner based on years of experience. If the markets or regulatory agencies don’t cooperate on the IPO schedule, then we just have to make sure our investments can keep growing without an IPO.

Me: As a strategy, it can’t be faulted. In a nutshell, it’s “Get in, get out, get carry and get new capital allocations from one’s LPs.”

My doubts are down on the practical level. Are there really deals like this in the market? If so, I certainly don’t see them. I’m just one guy feeling the elephant’s tail, and so have nothing like the people, sources that your firm has in China. Maybe there are lots of these kinds of opportunities, well-run Chinese companies with pre-money valuations of +USD$200mn (implying net income of +USD$20mn), and so probably large enough to IPO now, but still looking, somewhat illogically,  to raise outside PE money from a dollar fund at a discount to public markets.  Maybe too there are enough to go around to fill the strategic needs of not just your firm but about every other one active here, including not only the RMB crowd, but all the other big global guys, who also say they want to find ways to write big dollar checks in China and exit these deals within 2-3 years. (This is, after all, the genesis of the craze to throw money into PtP deals in the US, none of which have made anyone any money up to this point.)

Is China deal flow a match for this China strategy? That’s the part I’ll be watching most closely.

My empirical view is that the gap may be growing dangerously ever wider between what China PEs are seeking and what the China market has to offer. This is a country where the best growth capital deals and best risk-adjusted investments are concentrated among entrepreneurial private sector businesses with (sane) valuations below $100mn. In other markets, scale is inversely correlated with risk. In China, it is probably the opposite. Bigger deals here usually have more hair on them than an alpaca.

From our discussions over the years, I know you’re someone who looks at deals through a special, somewhat contrarian prism. Your firm’s new strategy pulls in one direction, while your own inclinations, judgment and experience may perhaps pull you in another.

We’re finishing up now a “What’s ahead in 2014″ Chinese-language report that we’ll distribute to the +6,500 Chinese company bosses, senior management and Chinese government officials in our database.  I’ll send a copy when it’s done. You’ll see we’re basically forecasting 2014 will be a better year to operate and finance a business in China than the last two years. Our view is good Chinese companies should seize the moment, and try to outrun and outgun their competitors.  Your role: supply the fuel, supply the ammo.

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IPO rules overhauled for PE and VC firms — China Daily

Leave a Comment / May 1, 2014

China Daily article

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Shanghai stock exchange trading floor

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Friday, January 3, 2014

Private equity and venture capital firms will have to conduct their business differently in China in 2014, after regulators overhauled initial public offering rules.

Chinese PE and VC companies used to evaluate the companies by the standards of the China Securities Regulatory Commission for quicker IPOs, but now the market will play a more important role, said Peter Fuhrman, chairman, founder and chief executive officer at China First Capital.

“Under the new IPO system, the share pricing of an IPO company is decided by its strength and competitiveness, so investors will choose companies with real potential to invest in and provide them with the resources of strategy, management and market development to make their own return the best,” said Fuhrman *.

Private equity and venture capital firms will not find it easy to earn money any more after the new share-listing reform plan is carried out, because even if the companies they invested in get listed, they will still face the risk of losses, said Jin Haitao, chairman of leading Chinese equity investment firm Shenzhen Capital Group Co Ltd.

Jin said PE and VC institutions should cultivate real investment capabilities including those in value-discovery and negotiating. Pre-IPO deals cannot be guaranteed to earn money any more.

A total of 83 Chinese companies completed the examination and received approval from the China Securities Regulatory Commission. About 50 are expected to have finished all IPO procedures and be listed before the end of January. More than 760 companies are in line for approval. It will take about a year to audit all the applications.

In the IPO reform plan announced at the end of November, information disclosure has become more important and the China Securities Regulatory Commission will only be responsible for examining applicants’ qualifications, leaving investors and the markets to make their own judgments about a company’s value and the risks of buying its shares.

More and more Chinese companies applying for IPOs asked for cooperation with multinational accounting institutions, according to Hoffman Cheong, an assurance leader at Ernst & Young China North Region.

Cheong said the information disclosed can be different after the IPO reform plan is carried out.

According to the IPO reform plan, so long as an issuer’s prospectus is received by the commission, it will be released on the commission’s website. The company should buy back shares if there is a false statement or major omission. Also it should compensate investors if they lose money in certain situations.

http://www.chinadailyasia.com/business/2014-01/03/content_15109395.html

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(* Note: I never spoke to the reporter. As far as I can tell, the quote was translated into English, rather clumsily, from a Chinese-language commentary of mine published recently in a Chinese business publication. If asked, I would have said that companies need to choose PE investors carefully, and vice versa.)–

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China’s IPO Freeze to Melt in Midwinter

Leave a Comment / December 2, 2013

Kesi embroidery

IPOs are returning to China. The China Securities Regulatory Commission this weekend announced its long-awaited guidelines on a new, somewhat liberalized process for approving IPOs. The rush is now on to get new IPOs approved and the money raised before Chinese New Year, which falls on January 31st, less than two months from now. Ultimately, the CSRC hopes to clear within one year the backlog of over 800 Chinese companies now with IPO applications on file. Thousands of other Chinese companies are waiting for the opportunity to submit their IPO plans. The CSRC stopped accepting new applicants almost 18 months ago.

From what I can tell, the CSRC has concluded, rightly, its old IPO approval process was broken beyond repair. The regulator used to take primary responsibility for determining if a Chinese company was stable enough, strong enough, honest enough to be trusted with the public’s money. No other securities regulator took such a hands-on, the “buck stops with me” approach to IPO approvals. The CSRC now seems prepared to pass the buck, in other words, to put the onus where it belongs, on IPO applicants, as well as the underwriters, lawyers and accountants.

This should eliminate the moral hazard created by the old system. Companies, as well as their brokers and advisors, had a huge amount to gain, and much less to lose, by submitting an application and hoping for a CSRC approval. They could cut corners knowing the CSRC wouldn’t. For the successful IPO applicants who got the CSRC green light, valuations were sky-high, and so were underwriting and advisory fees.

Going forward, the CSRC seems determined to switch from security guard to prosecutor. Rather than trying to detect and prevent all wrongdoing, it is now saying it will punish severely companies, and their outside advisors, where there’s a breach in China’s tough securities laws. The CSRC’s powers to punish any wrongdoing are significant. Heaven help those who end up being convicted of criminal negligence or fraud. As I noted before,  there are no country club prisons in China for white collar offenders.

While baring its sharp teeth, the CSRC is also now using its more soothing voice to tell retail stock market investors they will need to do more of their own homework. It wants more and better disclosure from companies. It hopes investors will read before buying. And, the CSRC also hopes the stock market will itself begin to provide investors will clearer signals, through share price movements, on which companies may not be suitable for the more risk-averse.

Up to now, companies going public in China did so with a kind of “CSRC Warranty”. That’s because the CSRC itself said it had already done far more detailed, forensic scrutiny of the company than just reading through its public disclosure documents. The approval process could take two years or more, with company execs, lawyers and accountants being called frequently to meetings at the CSRC headquarters to be grilled. All this to give comfort to investors that nothing was awry.

The warranty has effectively been revoked. This may make some investors more nervous, but it represents a significant and positive breakthrough for the CSRC.

It needs to lighten its grip. Markets need regulation, need rules and effective mechanisms for punishing bad actors. But, the CSRC took on too much responsibility for assuring the orderly functioning of China’s stock market. This was always going to be difficult. China’s stock markets are far more prone to speculative frenzy than stock markets in the US, Europe. Shares on the Shanghai and Shenzhen stock markets are bought and sold mainly by retail investors, or as the Chinese say, “old granddads and grannies” (老爷爷老奶奶）. Institutional investors are a minority. As for investment fundamentals, on China’s stock market there are mainly just two:  “Buy on rumor. Sell on rumor”.

Over the last year, I’ve written about problems at the CSRC that helped cause and prolong this long freeze in IPOs. The CSRC’s first instinct back in 2012 was to try to toughen its regulation, toughen its own internal systems and procedures for rooting out fraud. It then switched tracks, and decided to let the market play more of a role.  This is a major concession, as well as important proof that China’s larger process of economic transformation, of freeing rather than freezing markets, is headed in the correct direction.

As if on cue, this past week’s Wall Street Journal last week digested a section from the Nobel Prize acceptance speech by economist Friedrich Hayek.

“To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm…Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. ”

I’m delighted China’s IPO market is going to re-open. My own prediction here a couple of months ago was that it IPOs would resume around now, rather than next month. This just goes to show all forms of market timing — whether it’s trying to guess when a stock price has hit its peak or when a stock market itself will change course, and its once omnipotent regulator change its entire approach — is a fool’s errand.

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